Start With Balanced Funds' Convenience and Diversity

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By Meg Richards
Associated Press
Sunday, April 16, 2006

If you've been putting off opening an investment account outside your retirement savings, there's an easy way to get started: Use a balanced fund.

These ready-made portfolios combine stocks, bonds and cash, providing investors with instant diversity, often with low expenses. In addition to the ease of one-stop shopping, balanced funds typically deliver a smoother ride than pure stock funds, said Eric Tyson, a former financial counselor and author of several investing books, including "Mind Over Money: Your Path to Wealth and Happiness."

For many of us, this makes them a more palatable choice. That's because people who track share prices to see how their investments are doing will find less variability with balanced funds than they would in a similarly allocated portfolio of multiple funds.

"I've long loved balanced funds, especially for skittish investors, because the bonds mask the volatility of the stocks," Tyson said. "When I was doing financial planning, I saw that people often had a hard time keeping in mind the overall portfolio, and a balanced fund kind of forces them to do that."

If you're looking for a fund to hold outside a retirement account, the taxes associated with the bond income of balanced funds may make you think twice about owning one, particularly if you're in a higher income bracket or live in a high-tax state. If you find a balanced fund doesn't make sense for your tax situation, you may be better off building your own balanced portfolio with municipal bonds, which are exempt from federal taxes.

There are fund portfolios that address this issue, however, including V anguard Tax-Managed Balanced (VTMFX), which provides federally tax-exempt returns through the use of municipal bonds and by avoiding the market's highest-yielding stocks. This portfolio, which targets a 50/50 split between stocks and bonds, also charges rock-bottom expenses.

Not all balanced funds are built the same; their asset allocation and level of risk will depend on the aims and philosophy of management. They may be extremely conservative with as little as 30 percent in equities, or more aggressive with high stakes in foreign stocks and hot sectors.

The first thing to consider when shopping for a balanced fund is your own time horizon, said John Sweeney, senior vice president of mutual fund product management at Fidelity Personal Investments.

"Obviously, if you've got shorter-term horizons, you should be in cash or short-term bonds, but if you've got a multiyear timeline, a 60/40 portfolio will serve you in great stead," Sweeney said. "I wouldn't advocate it for someone who is trying to buy a house next year. . . . They should be in a money market fund. But for someone with a five-year-plus time horizon, it would be very appropriate."

Fund-tracker Morningstar breaks balanced funds into two categories; those that take on less equity risk are called "conservative allocation," and those that take on more are called "moderate allocation." If you are saving for a goal that's less than five years away, you'd want a more conservative choice. Morningstar's picks in this category include Vanguard Wellesley Income (VWINX), which keeps about 60 percent of assets in bonds and focuses on dividend-paying stocks. Another choice, T. Rowe Price Personal Strategy Income (PRSIX), has more equities, including some foreign stocks, and holds high-yield bonds and some foreign debt, but has still managed to keep volatility low. Both are no-load funds with low expenses.

If your goal is a decade or more away, you could take on modestly more risk with a fund that has a higher stake in stocks, say between 60 percent and 70 percent. But you could still rely on the bond allocation to stabilize your portfolio.

"If all you're buying is equity exposure, you're going to get equity volatility," Sweeney noted. "If you're 40 percent fixed income, you're sleeping much better at night . . . and you're probably going to wind up beating the Standard & Poor's 500 over time."

That's been the case for Fidelity Balanced Fund (FBALX), a portfolio that is 60 percent equities with the remainder in bonds and cash. Its performance tops that of the S&P 500 over the trailing one-, three-, five- and 10-year periods, and in that time, it's beaten most of its peers.

Morningstar's top picks in the moderate-allocation category include American Funds Income Fund of America (AMECX), the largest balanced fund in terms of assets, which divides its portfolio between dividend-paying energy, utility and financial-services stocks and high-quality debt and a handful of high-yield bonds. Fidelity Asset Manager (FASMX) is a more neutral choice, with a relatively light 50 percent of assets in stocks and a modest cash stake. And growth-oriented Pax World Balanced (PAXWX) invests according to socially conscious guidelines, with exposure to domestic blue-chips, mid-caps and overseas stocks that satisfy the firm's criteria, as well as agency-backed and investment-grade corporate debt.

© 2006 The Washington Post Company

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